Has Enzymotec Been Over-Punished?

Jun. 9.14 | About: Enzymotec Ltd. (ENZY)

Summary

Enzymotec reported Q1'14 results with a disappointing revenue forecast, and provided a disappointing status update on the license agreement with Neptune Technologies.

The stock price reacted with a sharp decline.

However, revenue decrease drivers are related to short-term events, Vaya and InFat sales are growing, and cash management is positive.

On May 14, Enzymotec (NASDAQ:ENZY) announced its results for the first quarter of 2014, and provided EPS guidance for the full year. In the earnings call, Enzymotec executives mentioned a decrease in estimated revenues and a status update on the license agreement with Neptune Technologies & Bioresources Inc. (NASDAQ:NEPT). Enzymotec stock reacted drastically; the price at the closing was $13.75, reflecting a 32% decline that day, an over-50% decline since the secondary offering in March, and just slightly below the initial offering price of $14. Was this harsh reaction justified or an extreme punishment that will be corrected in the long run?

Decrease in estimated revenues

Enzymotec provided lower revenues guidance for the fiscal year 2014 and Q2'14 than the guidance it provided previously. CFO Oren Bryan mentioned three reasons for the decrease:

  1. Manufacturing shutdown due to installation of new manufacturing equipment will impact revenues in Q2'14.
  2. Adjustments to infant nutrition production chain due to regulatory changes in China will result in a revenues shift from Q2 to the second half of 2014.
  3. US weather impact on the company's revenues is partially offset by higher demand in Europe and Asia.

Although the revenues guidance is disappointing and provides a wide range from $68M to $85M, all the reasons mentioned above are short-term related and have no impact in the long run: new manufacturing equipment is expected to increase sales capacity in the future, Chinese regulation changes are a one-time adjustment, and the impact of US weather on retail sales has been widely discussed by Wal-Mart, Target, and other retailers, and is not expected to have any long-term impact on Enzymotec's sales.

Status update on the license agreement with Neptune

Enzymotec's CEO, Ariel Katz announced that the company signed a final agreement with Neptune, in which Enzymotec receives a worldwide non-exclusive license to the entire 348 patent family for as long as any patent in the family exists, as well as for future products. Enzymotec made a one-off payment to Neptune, which was reflected in Enzymotec's sales and marketing in Q1'14. The krill oil royalties' status is still unclear, as Enzymotec might be obligated to pay royalties in North America if the inter-party review is unfavorable for the company, and in Australia if the reexamination is unfavorable. This uncertainty around future royalties casts a shadow over the company's gross margin forecast, and is driving investors away from this stock until the uncertainty is clarified.

Revisiting the highlights I described in my previous Enzymotec article

In my previous Enzymotec article, I raised three questions to look for in the earnings call. Here are my answers:

  1. Vaya Pharma growth status and sales update: According to Bryan, Vaya Pharma's sales improved quarter-over-quarter; however, there are no material sales from the new team. Material sales are expected from Q2 once the new team is fully trained. I will keep this item on my list and revisit it after the second-quarter earnings release.
  2. InFat sales progress and strategic partnership status update: Enzymotec reports increased Infat sales through the Advanced Lipids joint venture. As to the strategic partnership, CEO Ariel Katz mentioned that sales of Wyeth's (now Nestle infant nutrition division) premium products that contain InFat or "OPO" are increasing. This is surely a step in the right direction for Enzymotec; however, the company should increase efforts to gain a bigger market share in China, the biggest infant nutrition market in the world.
  3. Polar Omega joint venture and fish oil-based omega-3 status update: Enzymotec provided very little details about the new fish oil-based omega-3 product. Ariel Katz noted that the product will be launched in Q2'14, will be more innovative than other products that exist in the market, and should bring a new benefit to customers. I will follow up with this new product line during the year.

Cash balance and cash flow

Enzymotec has $75M in cash, and no long-term debt. In Q1'14, Enzymotec generated $4.8M in cash from operating activities, which is a 100% increase from the $2.4M the company generated in Q1'13. The increase in cash provided from present operating activities shows the company's ability to generate cash from its business model, and is a positive sign for the future. The large amount of cash the company has can assist the company with future investments, such as plant expansion, increased product development, or strategic acquisition. All of these investment alternatives can improve the company's financials and portfolio in the long term, but are usually not favored by investors who prefer dividend payments or buybacks to improve their return on investment in the short term.

Conclusions

Major events reported in Q1'14 earnings have a short-term impact only on Enzymotec. The revenues decrease discussed in Q1'14 earnings is driven by specific one-time events, and has no impact on Enzymotec's long-term results. The license agreement with Neptune resulted in a single payment and no future royalties for the moment. Uncertainty with some aspects of the future payments puts some pressure on the stock price in the short term; however, once additional reviews and examinations are over, this pressure should be removed. The company reports good progress in the Vaya Pharma segment and InFat sales that should have a positive impact on the company's financials later this year.

Enzymotec's high cash balance, positive cash flow trend, and lack of long-term debt should make it appealing for investors; however, announcing a new large investment using that pile of cash may cause another drop in stock price. In order to prevent that, Enzymotec should announce a buyback program or dividend policy to add value to its stock.

Disclosure: I am long ENZY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Information provided in this article is for informational purposes only and should not be regarded as investment advice or a recommendation regarding any particular security or course of action. This information is the writer's personal opinion about the companies mentioned in the article. Investors should conduct their own due diligence and consult with a registered financial adviser before making any investment decision. Lior Ronen and Finro Financial Consulting and Analysis are not registered financial advisers and shall not have any liability for any damages of any kind whatsoever relating to this material. By accepting this material, you acknowledge, understand and accept the foregoing.